Data room – a specific location where potential buyers / investors can review confidential information about a target company. This information may include detailed financial statements, client contracts, intellectual property, property leases, and compensation agreements.
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Deal flow – a measure of the number of potential investments that a fund reviews in any given period.
Debt service ratio – the ratio of a required loan payment amount (“debt service”) to available cash flow earned during a specific period. Typically lenders insist that a company maintain a certain debt service ratio or else risk penalties such as having to pay off the loan immediately.
Defined benefit plan – a company retirement plan in which the benefits are typically based on an employee’s salary and number of years worked. Fixed benefits are paid after the employee retires. The employer bears the investment risk and is committed to providing the benefits to the employee. Defined benefit plan managers can invest in private equity funds.
Defined contribution plan – a company retirement plan in which the employee elects to contribute some portion of his or her salary into a retirement plan, such as a 401(k) or 403(b). The employer may also contribute to the employee’s plan. With this type of plan, the employee bears the investment risk. The benefits depend solely on the amount of money made from investing the employee’s contributions. Defined contribution plan capital cannot be invested in private equity funds.
Demand rights – a type of registration right. Demand rights give an investor the right to force a startup to register its shares with the SEC and prepare for a public sale of stock (IPO).
Denominator effect - an imbalance in asset allocation targets from one year to the next due to a significant change in the overall value of a portfolio. For example, if 10% of a portfolio is invested in private equity as planned but the total portfolio value (the denominator) drops significantly due to stock market volatility, the portfolio manager may have to stop investing or sell stakes in private equity funds in order to rebalance the private equity allocation to the 10% goal.
Dilution – the reduction in the ownership percentage of current investors, founders and employees caused by the issuance of new shares to new investors.
Disbursement – an investment by a fund in a company.
Discount rate – the interest rate used to determine the present value of a series of future cash flows.
Discounted cash flow (DCF) – a valuation methodology whereby the present value of all future cash flows expected from a company is calculated.
Distressed debt – the bonds of a company that is either in or approaching bankruptcy. Some private equity funds specialize in purchasing such debt at deep discounts with the expectation of exerting influence in the restructuring of the company and then selling the debt once the company has meaningfully recovered.
Distribution – the transfer of cash or securities to a limited partner resulting from the sale, liquidation or IPO of one or more portfolio companies in which a general partner chose to invest.
Dividends – payments made by a company to the owners of certain securities. Typically, dividends are paid quarterly, by approval of the board of directors, to owners of preferred stock.
Down round – a round of financing whereby the valuation of the company is lower than the value determined by investors in an earlier round.
Drag-along rights – the contractual right of an investor in a company to force all other investors to agree to a specific action, such as the sale of the company.
Drawdown schedule – an estimate of the gradual transfer of committed investment funds from the limited partners of a private equity fund to the general partners.
Drive-by VC – a venture capitalist that only appears during board meetings of a portfolio company and rarely offers advice to management.
Due diligence – the investigatory process performed or commissioned by investors to assess the viability of a potential investment and the accuracy of the information provided by the target company. In the case of an auction process, the vendor may commission an independent due diligence report which can be shared with multiple bidders, with the option of 'top-up' due diligence later in the process.
Dutch auction – a method of conducting an IPO whereby newly issued shares of stock are committed to the highest bidder, then, if any shares remain, to the next highest bidder, and so on until all the shares are committed. Note that the price per share paid by all buyers is the price commitment of the buyer of the last share.
Early stage – the state of a company after the seed (formation) stage but before middle stage (generating revenues). Typically, a company in early stage will have a core management team and a proven concept or product, but no positive cash flow.
Earnings before interest and taxes (EBIT) – a measurement of the operating profit of a company. One possible valuation methodology is based on a comparison of private and public companies’ value as a multiple of EBIT.
Earnings before interest, taxes, depreciation and amortization (EBITDA) – a measurement of the cash flow of a company. One possible valuation methodology is based on a comparison of private and public companies’ value as a multiple of EBITDA.
Earn out – an arrangement in which sellers of a business receive additional future payments, usually based on financial performance metrics such as revenue or net income.
Elevator pitch – a concise presentation, lasting only a few minutes (an elevator ride), by an entrepreneur to a potential investor about an investment opportunity.
Employee Stock Ownership Program (ESOP) – a plan established by a company to reserve shares for employees.
Enterprise Value (EV) – the sum of the market values of the common stock and long term debt of a company, minus excess cash.
Entrepreneur – an individual who starts his or her own business.
Entrepreneurship – the application of innovative leadership to limited resources in order to create exceptional value.
Equity – the ownership structure of a company represented by common shares, preferred shares or unit interests. Equity = Assets – Liabilities. Equity value can also be considered to be the proceeds from sale available to stockholders after all debt and other expenses have been deducted from enterprise value.
EVCA – European Private Equity and Venture Capital Association, an EU trade association for all forms of private equity.
Evergreen fund – a fund that reinvests its profits in order to ensure the availability of capital for future investments.
Exit strategy – the plan for generating profits for owners and investors of a company. Typically, the options are to merge, be acquired or make an initial public offering (IPO). An alternative is to recapitalize (re-leverage the company and then pay dividends to shareholders).
Expansion stage – the stage of a company characterized by a complete management team and a substantial increase in revenues.
Fair value – a financial reporting principle for valuing assets and liabilities, for example, portfolio companies in venture capital fund portfolios. This has received much recent attention as the Financial Accounting Standards Board (FASB) has issued definitive guidance (FAS 157) on this long standing principle.
Firm commitment – a commitment by a syndicate of investment banks to purchase all the shares available for sale in a public offering of a company. The shares will then be resold to investors by the syndicate.
First refusal – the right of a privately owned company to purchase any shares that employees would like to sell.
Founder – a person who participates in the creation of a company. Typically, founders manage the company until it has enough capital to hire professional managers.
Founders stock – nominally priced common stock issued to founders, officers, employees, directors, and consultants.
Free cash flow to equity (FCFE) – the cash flow available after operating expenses, interest payments on debt, taxes, net principal repayments, preferred stock dividends, reinvestment needs and changes in working capital. In a discounted cash flow model to determine the value of the equity of a firm using FCFE, the discount rate used is the cost of equity.
Free cash flow to the firm (FCFF) – the operating cash flow available after operating expenses, taxes, reinvestment needs and changes in working capital, but before any interest payments on debt are made. In a discounted cash flow model to determine the enterprise value of a firm using FCFF, the discount rate used is the weighted average cost of capital (WACC).
Friends and family financing – capital provided by the friends and family of founders of an early stage company. Founders should be careful not to create an ownership structure that may hinder the participation of professional investors once the company begins to achieve success.
Full ratchet – an anti-dilution protection mechanism whereby the price per share of the preferred stock of investor A is adjusted downward due to the issuance of new preferred shares to new investor B at a price lower than the price investor A originally received. Investor A’s preferred stock is repriced to match the price of investor B’s preferred stock. Usually as a result of the implementation of a ratchet, company management and employees who own a fixed amount of common shares suffer significant dilution. See Narrow-based weighted average anti-dilution and Broad-based weighted average anti-dilution.
Fully diluted basis – a methodology for calculating any per share ratios whereby the denominator is the total number of shares issued by the company on the assumption that all warrants and options are exercised and preferred stock converted.
Fund-of-funds – a fund created to invest in private equity funds. Typically, individual investors and relatively small institutional investors participate in a fund-of-funds to minimize their portfolio management efforts.
Gatekeepers – intermediaries which endowments, pension funds and other institutional investors use as advisors regarding private equity investments.
General partner (GP) – a class of partner in a partnership. The general partner retains liability for the actions of the partnership. In the private equity world, the GP is the fund manager while the limited partners (LPs) are the institutional and high net worth investors in the partnership. The GP earns a management fee and a percentage of profits (see Carried interest).
Going-private transaction – when a public company chooses to pay off all public investors, delist from all stock exchanges, and become owned by management, employees, and select private investors. Also known as a Public-to-private transaction.
Golden handcuffs – financial incentives that discourage founders and / or important employees from leaving a company before a predetermined date or important milestone.
Grossing up – an adjustment of an option pool for management and employees of a company which increases the number of shares available over time. This usually occurs after a financing round whereby one or more investors receive a relatively large percentage of the company. Without a grossing up, managers and employees would suffer the financial and emotional consequences of dilution, thereby potentially affecting the overall performance of the company.
Hart-Scott-Rodino Act – a law requiring entities that acquire certain amounts of stock or assets of a company to inform the Federal Trade Commission and the Department of Justice and to observe a waiting period before completing the transaction.
Harvest – to generate cash or stock from the sale or IPO of companies in a private equity portfolio of investments.
Hedge fund – an investment fund that has the ability to use leverage, take short positions in securities, or use a variety of derivative instruments in order to achieve a return that is relatively less correlated to the performance of typical indices (such as the S&P 500) than traditional long-only funds. Hedge fund managers are typically compensated based on assets under management as well as fund performance.
High yield debt – debt issued via public offering or public placement (Rule 144A) that is rated below investment grade by S&P or Moody’s. This means that the debt is rated below the top four rating categories (i.e. S&P BB+, Moody’s Ba2 or below). The lower rating is indicative of higher risk of default, and therefore the debt carries a higher coupon or yield than investment grade debt. Also referred to as Junk bonds or Sub-investment grade debt.
Hockey stick – the general shape and form of a chart showing revenue, customers, cash or some other financial or operational measure that increases dramatically at some point in the future. Entrepreneurs often develop business plans with hockey stick charts to impress potential investors.
Holding period – amount of time an investment remains in a portfolio.
Hot issue – stock in an initial public offering that is in high demand.
Hot money – capital from investors that have no tolerance for lack of results by the investment manager and move quickly to withdraw at the first sign of trouble.
Hurdle rate – a minimum rate of return required before an investor will make an investment.